Despite the Reserve Bank of India's ( RBI) aggressive cuts to policy interest rates, borrowers are not seeing the expected reduction in loan rates. This disconnect is because of a complex interplay between bond markets and inflationary expectations, leaving both the government and the central bank concerned about the stalled transmission of rate cuts, The Times of India reported on September 1.
Since February of this year, the RBI has lowered its policy rates by a substantial 100 basis points, yet the yield on 10-year government bonds has risen sharply.
On June 6, around the time of the last rate cut, the yield stood at 6.23%, while recent figures show this has climbed to 6.59%. Such a divergence is atypical; traditionally, one would expect bond yields to fall in response to rate cuts, as cheaper borrowing costs should stimulate investment and consumption.
Several factors contribute to this unusual situation. A significant concern is the long-term inflationary expectations that are beginning to take hold among investors, ToI's report (by Partha Sinha) said.
Although consumer inflation came in at a mere 1.6% in July -- a multi-year low -- market participants are bracing for a rebound going forward. Sandeep Bagla, CEO of Trust Mutual Fund, told ToI that while current inflation metrics are low, the outlook for future inflation remains much higher.
It may be noted here that the RBI has projected consumer inflation for FY26 at 3.1%, with expectations of it rising to 4.9% by the first quarter of FY27.
This anticipation of rising inflation is compounded by a critical liquidity channel for banks -- the open market operations (OMOs) -- being closed by the RBI. These operations are vital for managing liquidity in the banking system, and their restriction has created uncertainty in the bond market.
Investors are responding by demanding higher yields as a form of protection against future inflation, reflecting a broader global trend where central bankers lower short-term rates, yet bond yields continue to climb.
Also, the current fiscal landscape is influencing bond market sentiments. The impending cuts in Goods and Services Tax (GST) rates are expected to result in significant revenue losses for both central and state governments.
This raises concerns among bond market players about whether the governments will resort to more borrowing to compensate for these losses, potentially putting further upward pressure on bond yields.
Devang Shah, head of fixed income at Axis Mutual Fund, described this scenario as a "notable dislocation" in the market. He attributed the rising yields to structural imbalances, changing fiscal expectations and shifting regulatory dynamics.
Here's the logic: As bond yields increase, the cost of borrowing remains high, preventing banks from lowering interest rates on loans in line with RBI's cuts.
Since February of this year, the RBI has lowered its policy rates by a substantial 100 basis points, yet the yield on 10-year government bonds has risen sharply.
On June 6, around the time of the last rate cut, the yield stood at 6.23%, while recent figures show this has climbed to 6.59%. Such a divergence is atypical; traditionally, one would expect bond yields to fall in response to rate cuts, as cheaper borrowing costs should stimulate investment and consumption.
Several factors contribute to this unusual situation. A significant concern is the long-term inflationary expectations that are beginning to take hold among investors, ToI's report (by Partha Sinha) said.
Although consumer inflation came in at a mere 1.6% in July -- a multi-year low -- market participants are bracing for a rebound going forward. Sandeep Bagla, CEO of Trust Mutual Fund, told ToI that while current inflation metrics are low, the outlook for future inflation remains much higher.
It may be noted here that the RBI has projected consumer inflation for FY26 at 3.1%, with expectations of it rising to 4.9% by the first quarter of FY27.
This anticipation of rising inflation is compounded by a critical liquidity channel for banks -- the open market operations (OMOs) -- being closed by the RBI. These operations are vital for managing liquidity in the banking system, and their restriction has created uncertainty in the bond market.
Investors are responding by demanding higher yields as a form of protection against future inflation, reflecting a broader global trend where central bankers lower short-term rates, yet bond yields continue to climb.
Also, the current fiscal landscape is influencing bond market sentiments. The impending cuts in Goods and Services Tax (GST) rates are expected to result in significant revenue losses for both central and state governments.
This raises concerns among bond market players about whether the governments will resort to more borrowing to compensate for these losses, potentially putting further upward pressure on bond yields.
Devang Shah, head of fixed income at Axis Mutual Fund, described this scenario as a "notable dislocation" in the market. He attributed the rising yields to structural imbalances, changing fiscal expectations and shifting regulatory dynamics.
Here's the logic: As bond yields increase, the cost of borrowing remains high, preventing banks from lowering interest rates on loans in line with RBI's cuts.
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